Ottawa had little choice in signing controversial deal with U.S. tax man

On Canada Day and thereafter, Canadians or anyone else living in this country who walk into a bank to open up an account, invest in a mutual fund or buy life insurance will be required to prove that they are not American.

Canadian banks will soon begin collecting detailed citizenship and residency information about their clients, some of which will make its way through the Canada Revenue Agency to authorities in the United States as that country cracks down on tax cheats.

That is the new reality now that the federal government in Ottawa finally buckled and signed onto a controversial U.S. tax agreement this week — the Foreign Account Tax Compliance Act (FATCA) — requiring financial institutions around the world to disclose to the U.S. Internal Revenue Service information about foreign accounts held by American citizens and others who might owe money to the U.S. tax man. The primary purpose of FATCA is to identify U.S. citizens who aren’t reporting global incomes. International banks have been targeted because U.S. Congress is convinced they facilitate tax cheats through offshore accounts and other means. In 2010, it passed a law giving the IRS powers to pursue tax avoiders and evaders regardless of where they live.

The Intergovernmental Agreement (or IGA) Canada signed with the U.S. on Feb. 5 means as of July 1, Canadian banks, mutual funds, credit unions, life insurance companies and other financial institutions will collect names, addresses and financial information of U.S. citizens, green-card holders and permanent residents with money in Canada and pass it along to the Canada Revenue Agency. The CRA will pass along the information to the IRS, which is really targeting accounts worth US$50,000 or more. Any pre-existing accounts and investments will be forced to comply by 2016.

By no means is this a tidy law limited to Americans or dual citizens. Rather, it has the potential to snare a much larger number of unsuspecting Canadians in its dragnet. Here’s why: if you’re a Canadian citizen, holding only Canadian investments (including equities and bonds), and own no investments abroad or for that matter, may have never even traveled abroad, you will still be required to certify in Canada that you are not American. Is it any wonder why Ottawa’s decision to effectively ram an American initiative down the throats of Canadians has been widely criticized as a sell out by privacy groups and the financial industry?

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Furthermore, the cost of compliance and enforcement to create the reporting schemes necessary to collect detailed citizenship and residency information about their customers is an estimated $200-million for Canadian financial institutions. Guess who will pay for that? Don’t bet the burden of that tab will be borne solely by the estimated 300,000 Americans living in Canada. And since bank bashing is a national sport in this country, it’s understandable why the Canadian Bankers Association is publicly livid, and the pinstripes in the bank towers are privately fuming.

Still, what choice did Ottawa really have? The U.S. has already managed to get most major industrialized countries to adopt its rule. And the Organisation for Economic Co-operation and Development is expected to endorse the law in the next few months. If Canada resisted, financial institutions and their customers faced the threat of a whopping 30% withholding tax. Since Canada has more skin in the game given the amount of cross-border investments between Canada and the U.S., the punitive tax would have been potentially devastating. And keep in mind most of Canada’s major banks operate in countries that have already signed onto FATCA, making it difficult for them to avoid complying with it.

Thus to make this intrusive law more palatable for the banks, who are prohibited from dealing directly with a foreign government, Ottawa signed the agreement allowing the CRA to act as the go-between with the IRS since an information-sharing arrangement exists between the two tax agencies. To placate Canadians, Ottawa secured an exemption for some types of investments, such as RRSPs, Registered Educations Savings Plans (RESPs) and tax-free savings accounts.

Furthermore, Canada negotiated reciprocity from the U.S., which has in theory agreed to share financial information about foreign residents on a bi-lateral basis. In other words, Canada received a pledge that the U.S. will share similar information. The problem is the U.S. government hasn’t quite figured out how American financial institutions will scour their own books and records in search of tax evading Canadians. In fact, few expect the U.S. government will actually be able to deliver on this promise – and if so, in a timely fashion. After all, reciprocity is all in the details and it may not only be Canadians left fuming by this controversial initiative.